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Gas, Sweaters and the Case for Optimism in Europe

Gas, Sweaters, and the Case for Optimism in Europe
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Jeff Kleintop, Schwab's international expert, says there are plenty of reasons that investing in Europe makes perfect sense.

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Rick Karr:

My guest says it’s a good time to invest in Europe. I’m skeptical. I see an economy stuck in neutral, voters flirting with political extremists, Greece isn’t out of the woods; and when I’m there? I don’t sense burgeoning optimism or big opportunity. But take a listen to his argument and decide for yourself.

You're listening to the Insights & Ideas podcast brought to you by Charles Schwab, I'm Rick Karr. Jeff Kleintop is our go-to guy when the topic is investing outside the U.S. Jeff keeps an eye on what’s going on around the world at Charles Schwab and figures out what it all means for investors. I asked him right off the bat about the continent’s politics.

Voters haven’t shown much enthusiasm for the political parties that usually form their governments. Last year France’s right-wing National Front won a third of the country's seats in the European parliament. Polls in Britain showed the anti-immigrant United Kingdom Independence party gaining in the polls. Greece meanwhile embraced the left, and a Spanish party formed by students during protests against austerity measures was looking like a serious contender there. Jeff says it’s looking like ideology had nothing to do with that. To coin a phrase: “It was the economy, stupid.”

Jeff Kleintop:

Remember Europe was in recession in 2011 and ’12 and into ’13, so the status quo didn’t look very good, and an alternative was very attractive. That since faded as growth has returned to the zone. You know the Spanish party that had led the polls earlier this year, the one that wanted to follow the Greek lead, they lost a significant amount of support. In fact, in the September elections in the Spanish region of Catalonia they got only 9 percent of the vote—that compares to over 30 percent earlier this year. And that left-wing party that won the Greek elections late last year, they had to accept Europe’s terms for another bailout, and they had to renege on many of their promises for a more radical approach to politics there. Probably the best example is in the U.K. People were worried about voters moving further from the mainstream, and the opposite occurred. Tories won convincingly with an outright majority back in elections in the spring. So the mainstream’s made a comeback as economic growth has returned to the region, and the anti-establishment parties have failed to make a strong case.

Rick Karr:

You mention the debt crisis. Is Greece really out of the woods here? Is Spain really out of the woods for that matter? Or Portugal? Any of those countries in the periphery, especially Greece though.

Jeff Kleintop:

Well, look, Greece still has some problems. It’s got a lot of debt and it’s facing a lot of economic hurdles. I think there’s still a 50 percent chance it could leave the Eurozone, but I don’t think that’s likely to cause a crisis. Greece is a very small economy and its debt is no longer in the hands of private investors, so it’s unlikely to cause a major crisis if it were to leave the Eurozone. But look, while we’re watching the back door to see if Greece might leave the Eurozone, we’ve got a lot of new members coming into the zone through the front door: Latvia, Lithuania, Estonia all recently joined the Eurozone. In fact, the Eurozone’s more popular than ever. It’s now got 19 members sharing that common currency, up from the 11 original countries back in 1999. You know, one more point on this exit talk, the lack of an equal balance of growth and support across countries in Europe causes some people, I think, to fear a breakup, but that’s not unusual. You know, this October makes it 25 years since Germany reunified, and in Germany the East still lags the West. In fact all 30 of the companies in the German stock index are located in Western Germany. Yet, Germany is unlikely to split back up into the East and West of the Cold War. There are benefits to unification that go beyond social and economic differences, and I think these fears of a breakup in the Eurozone are overdone.

Rick Karr:

There are these two other things going on, though. First of all there is the fact that the European central bank is still doing quantitative easing to juice that economy, and refugees coming in. I mean my in-laws live in Munich—they have seen firsthand all of the people coming across the border, coming on to that train station. That’s got to be a stress on the entire continent.

Jeff Kleintop:

It’s a big deal. It is the biggest mass migration that Europe has seen in 40 or more years. But I don’t think it’s a negative. The spending on refugees actually acts a short-term economic stimulus. And that’s because money allocated to humanitarian agencies and the cash being provided directly to refugees is likely to be spent right away, and that gives a little bit of a short-term boost to the economy. Over the long term, Europe needs immigration. They’ve had a slowing workforce, even a shrinking workforce in some of the countries in Europe, and the increase in the number of workers resulting from this influx of migrants could help to alleviate this long-term threat to economic growth in Europe. Certainly there’s no assurance that the refugees will be able to find jobs, but there is some hope. About 70 percent of the increase in the workforce in Europe, over the past decade, has come from migrants. So there is some optimism there that this is actually going to be, maybe, a little bit beneficial in the long term and the short term for Europe

Rick Karr:

Okay, so I could say, Europe is a stable continent right now. It’s not maybe looking as bad as it has to me in the past. But, is it really growing? Is there growth potential right now? I mean, it feels like the continent never really recovered from the financial crisis a few years ago.

Jeff Kleintop:

The potential growth rate in Europe is slower than the U.S. The average growth rate, the trend growth rate, is just a little bit lower than what we experienced in the U.S. So it always feels like it’s lagging a little bit. But, you know, when you take a look at some of the measures I like to look at, and I like to look at the Purchasing Managers Index—one of my favorite indicators for economic performance—and in the fourth quarter of last year it started to turn up and now stands near a four-year high for the Eurozone. You can’t say that for the U.S. Consumer spending has also picked up. You know here in the U.S., low energy prices really didn’t translate into more consumer spending. We didn’t see less gas turn into more sweaters. But we did in Europe. In fact, in Italy new car registrations are up 17 percent over the past year, and that’s a good sign. You mention quantitative easing, you know basically what the Fed did here in the U.S. to help get the economy going in the five years after the crisis. well, it started in Europe back in March, and it’s going to continue to support markets and economic activity here that’s already showing a bit of a rebound. So all of those have combined to lift earnings in 2015 at a much better pace than we’ve seen in the U.S.

Rick Karr:

What kind of growth are we talking about, and what sectors would we be talking about?

Jeff Kleintop:

You know I think that Europe’s probably on a trajectory for about a 2 percent GDP growth rate, which is a little bit lower than what we might expect here in the U.S. But it’s had better momentum lately, and that has translated into better earnings growth. We’ve seen solid single-digit earnings growth in Europe this year, contrasting with flat numbers in 2015 for the U.S. So we’re lumbering along in the U.S., but they’re earlier in their economic cycle in Europe. Remember they just emerged from recession in 2013—that means they may have a little bit more room to grow. Probably the areas that look best, one of them, is a service sector: financials. It’s big here, but it’s even bigger in Europe. It’s actually 10 percent larger as a part of the stock market in Europe. And quantitative easing means the ECB is pumping a lot of cheap money into the banks just as individuals and businesses are taking out more loans to grow and making those loans easier to get. So it looks like a good sector that may lead the way for Europe.

Rick Karr:

Jeff, I’m going to start calling you Mr. Optimist from now on when I talk to you, because you were optimistic last time you were on Insights & Ideas. You’re optimistic about Europe. Is there anything that you could imagine that would make you pessimistic?

Jeff Kleintop:

Sure, and probably the biggest risk to Europe isn’t within the region itself, it’s a deeper slowdown within China. China’s a big trading partner with Europe and certainly buys a lot of big capital goods: equipment used at Chinese factories. If China were to slow a bit more dramatically than it is now, that could really be a pullback to a region that’s really been focused on—for example, Germany has been really focused on its exports lately, that could be a risk. A deeper slowdown in the U.S. as well would be a far deeper negative for Europe. It’s a region that, while it trades a lot within its own borders, is still pretty dependent on the rest of the world.

Rick Karr:

Well, I’ll tell you what, I’m going to be in Germany soon and when I get back I’ll report to you on what I’ve seen on the ground, okay?

Jeff Kleintop, thank you so much.

Jeff Kleintop:

My pleasure, thanks for having me.

Rick Karr:

That is it for this edition of the Insights & Ideas podcast brought to you by Charles Schwab. You can follow Jeff Kleintop on Twitter; his handle is JeffreyKleintop, J-E-F-F-R-E-Y K-L-E-I-N-T-O-P. You can find us on iTunes or at Insights.Schwab.com. Our producer is Matthew Nelson. I’m Rick Karr. Thank you for listening. 

Important Disclosures

Please note that this content was created as of the specific date indicated and reflects the speaker’s views as of that date. It will be kept solely for historical purposes, and the speaker’s opinions may change, without notice, in reaction to shifting economic, business, and other conditions. 

International investments involve additional risks, which include differences in financial accounting standards, currency fluctuations, geopolitical risk, foreign taxes and regulations, and the potential for illiquid markets.

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